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Clause 156

Banking Bill – in a Public Bill Committee at 1:00 pm on 23rd October 2008.

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Contingency funding

Photo of Mark Hoban Mark Hoban Shadow Minister (Treasury)

I beg to move amendment No. 34, in clause 156, page 81, line 4, after ‘the’, insert ‘Authority to make rules enabling the’.

Photo of Roger Gale Roger Gale Conservative, North Thanet

With this it will be convenient to discuss amendment

No. 35, in clause 156, page 81, leave out lines 7 to 9 and insert—

‘(2) Rules made by the Authority may make provision about the establishment and management of contingency funds provided that such rules are limited to the deposit protection element of the compensation scheme; in particular, the rules may make provision about—’.

Photo of Mark Hoban Mark Hoban Shadow Minister (Treasury)

We now move on to one of the less consensual issues in the Bill—contingency funding. We will come on to other amendments, and hopefully a clause stand part debate, to discuss some of the principles behind the issue.

Photo of Roger Gale Roger Gale Conservative, North Thanet

Order. Those of you who have not experienced my chairmanship should know that I have an absolute golden rule. I am particularly aware that complex issues can arise from a clause and I am perfectly prepared to have a broad debate on tabled amendments at the start of the clause. What I am not prepared to do is allow such debate twice. Therefore, if hon. Members choose to discuss certain issues early on to make the tabled amendments make more sense, that is fine by me, but they should not then expect a stand part debate.

Photo of Mark Hoban Mark Hoban Shadow Minister (Treasury)

As a veteran of your chairmanship, Mr. Gale, I know exactly where the limits are drawn on those matters, and I will seek to confine my remarks on the amendments precisely to how the regulations are made.

As the Minister alluded to earlier, the broad framework for the FSCS is set out in the 2000 Act. In that Act, the FSA has responsibility for drawing up the detailed regulations. Section 213 clearly states:

The Authority must by rules establish a scheme for compensating persons in cases where relevant persons are unable, or are likely to be unable, to satisfy claims against them.”

The responsibility to draw up the detailed rules therefore rests with the authority. Clause 156 of the Bill states that the Treasury will make regulations, not that the authority will make rules. Amendment No. 34 and the first part of amendment No. 35—I will not address the second part now as it pertains more to the next group of amendments—are designed to reassert the role of the FSA in making those detailed rules. Once the principle of contingent funding has been introduced by the Bill, and once the provision for that funding has been triggered, it is down to the FSA to make the rules and not to the Treasury to set out detailed regulations about how that funding may work in practice. This is therefore a straightforward pair of amendments.

Photo of Ian Pearson Ian Pearson Parliamentary Under-Secretary, Department for Business, Enterprise & Regulatory Reform, Economic Secretary, HM Treasury

The overall effect of the proposed amendments would be to divide responsibility for the introduction of pre-funding between the Treasury and the FSA. The Treasury, after obtaining parliamentary approval through the affirmative resolution procedure, would give the green light to the FSA to make rules to cover the matters set out in subsection (2) of proposed new section 214A.

It is not clear from the amendment whether the Treasury, with parliamentary approval, could set any high-level parameters in those areas. If the amendment were agreed by the Committee, we would need to do further work to clarify that point. However, I am not persuaded that a two-stage process for bringing in pre-funding is either necessary or desirable. The reality is that the Government would never seek to introduce pre-funding without consultation, including extensive consultation with the FSA, the Bank of England and the FSCS. Self-evidently, the Treasury would want to have a pretty good idea of what the FSA might plan to do in its rules before it sought parliamentary approval to give the FSA the green light. At the same time, it could not say to Parliament, “These are the rules that the FSA will make,” because FSA rules are a matter for the FSA.

It seems much better, therefore, that the Treasury should ask Parliament to approve all the key elements of any pre-funding package. In particular, we thought it right that Parliament should have the final say, through the affirmative resolution procedure, in a decision to allow levies to be imposed. Under the current pay-as-you-go system, the levies follow costs incurred by the FSCS or anticipate costs that the FSCS might incur in the near future. With pre-funding, levies may be imposed long before the FSCS incurs any costs, and costs will never be incurred if no default occurs.

Our approach is the right one, with the Treasury asking Parliament to approve all the key elements of any pre-funding package and with the affirmative resolution procedure, for which the hon. Member for Fareham has expressed a strong preference in previous debates. I ask the Committee to reject the amendments if they are pressed to a vote.

Photo of Mark Hoban Mark Hoban Shadow Minister (Treasury)

I am slightly perplexed by the Minister’s response. In the previous stand part debate, the Minister was happy to leave all the detail to the FSA to sort out: “It’s not up to us, guv. We’ll let the FSA decide all these  important issues.” Yet, in this scheme—the contingency funding clause—the Minister has taken an alternative view: “We’re going to do this, not the FSA.”

The Minister has not explained to the outside world why this approach is right for contingency funding, but the other approach is right for reform of the FSCS in the light of recent experience. I find that disappointing—there is a difference of approach. The Government clearly want to have the right to trigger contingency funding—for which the affirmative resolution procedure is right—but I do not understand why they have gone further than that, saying that they will set out the main principles of the legislation. It is not clear why there is a divergence of practice between the different parts of the scheme. It leaves external stakeholders confused about the Government’s approach. Does the Minister wish to clarify? I do not get the sense that he does, although I am happy to give way if he wants me to.

Photo of Ian Pearson Ian Pearson Parliamentary Under-Secretary, Department for Business, Enterprise & Regulatory Reform, Economic Secretary, HM Treasury

I do not accept that we are being inconsistent. If we introduce this, we need to be clear about the principles underpinning the FSA’s action, but it is up to the FSA to make its own rules. That is the process we have. A lot of the detail is rightly a matter for the FSA, but it is right and sensible that Parliament should agree the key principles. That is what we allow for in our approach. Amendments Nos. 34 and 35 would impose an unnecessary two-stage process, when we were going to work closely with the FSA on the issue.

Photo of Mark Hoban Mark Hoban Shadow Minister (Treasury)

I am not persuaded by the Minister on that point, because I think that there is a difference of approach between this and the previous group of amendments. I do not intend to press the amendment to a vote, but we might return to the matter on Report if the Government do not offer more clarity. I beg to ask leave to withdraw the amendment.

Amendment, by leave, withdrawn.

Photo of Mark Hoban Mark Hoban Shadow Minister (Treasury) 1:15 pm, 23rd October 2008

I beg to move amendment No. 2, in clause 156, page 81, line 6, after ‘expenses’, insert

‘relating to the powers exercisable under sections 10 to 12 and Parts 2 and 3 of the Banking Act 2008’.

Photo of Roger Gale Roger Gale Conservative, North Thanet

With this it will be convenient to discuss the following amendments: No. 1, in clause 156, page 81, line 12, leave out from first ‘the’ to end of line 13 and insert

‘contributions payable by banks and building societies’.

No. 3, in clause 156, page 81, line 16, leave out ‘classes of person’ and insert ‘banks and building societies’.

No. 8, in clause 156, page 81, line 23, after ‘compensation’, insert ‘for depositors’.

No. 5, in clause 156, page 81, line 27, at end insert—

‘(2A) In making any provision by virtue of subsection (2)(c) the Treasury must take account of the desirability of ensuring that the amount of the levies imposed on a particular class of authorised person reflects, so far as practicable, the amounts of claims made, in respect of that class of person.’.

No. 6, in clause 156, page 81, line 27, at end insert—

‘(2A) The amount of payments into the funds by virtue of subsection (2)(d) may vary between persons in each class.’.

No. 4, in clause 159, page 83, line 37, leave out ‘classes of person’ and insert ‘banks and building societies’.

No. 7, in clause 159, page 83, line 38, at end insert—

‘(4A) In making any provision by virtue of subsection (4)(c) the Treasury must take account of the desirability of ensuring that the amount of the levies imposed on a particular class of authorised person reflects, so far as practicable, the amount of claims made, in respect of that class of person.’.

Photo of Mark Hoban Mark Hoban Shadow Minister (Treasury)

It is clear from the proposed new section of the 2000 Act that the Government have set out contingency funding arrangements with a very broad scope. There is nothing in the proposed new section to indicate the limits on contingency funding. The amendments in this group try to tease out what the Government are trying to achieve through the proposed new section.

There are four strands running through my thoughts on these matters. Amendments Nos. 2 and 8 would restrict the scope of the Bill so that it only applied to deposit-taking institutions. Amendments Nos. 1, 3 and 4 suggest that only banks or building societies foot the Bill for the contingency funding scheme. Amendments Nos. 5 and 7 look at how the FSCS will raise its levy if there is a wider scheme. Amendment No. 6 raises the issue of risk weighting in relation to the contributions made to the contingency funding scheme.

Amendment No. 2 would require that the expenses discussed relate more narrowly

“to the powers exercisable under sections 10 to 12”, which relate to the special resolution regime,

“and Parts 2 and 3 of the Banking Act 2008”, which relate to bank insolvency and bank administration. The scope of the funding would be limited strictly to the exercise of the powers set out in the Bill. The amendment suggests that it would be inappropriate to use the contingency funding to set up a pre-pay fund for other parts of the financial services sector.

Although our discussions have been focused primarily on banks and building societies, the FSCS covers other aspects of the financial services sector such as insurance, insurance brokers, fund managers and independent financial advisers. It is a broad scheme, and we have been focusing on a subsection of customers within it. However, the breadth of the clause means that it would be possible for the Government to set up a pre-funding scheme that covered all of those sectors and not only banking.

There is a debate to be had on the extent to which the financial services sector as a whole should contribute to solving the problems faced by a subset of it. There is interdependence between the various subsets, so an element of contribution should be required from those subsets when losses are particularly high. That is the principle on which the FSCS is currently based. For example, if the cost of rectifying Bradford & Bingley were to exceed the amount set aside for banks to pay, that extra cost could be borne by independent financial advisers, insurance companies and investment managers. The principle of the scheme is currently based on such an idea, but we are talking about a pre-funding scheme  that could possibly involve contributions from other parties. By limiting pre-funding to the powers under the Bill, it would remove the risk of setting up a scheme that covers a much wider range of issues within the financial services sector.

Amendment No. 8 approaches matters in a slightly different way by restricting compensation to depositors. It applies to proposed subsection 214A(2)(g) of the 2000 Act under clause 156 of the Bill, and would exclude a fund being set up to pay for the compensation of people who hold insurance policies, who have taken up investments for a fund manager and who have been given advice by an independent financial adviser. It is a different way to limit the scope or the extent of the pre-funded scheme.

Amendments Nos. 1, 3 and 4 take a different approach to who contributes to the pre-funding scheme. They would replace the Government’s broad wording of “classes of person” with “banks and building societies” to make it clear that only those entities will pay towards the pre-funding scheme. In effect, we say that the only people who should be responsible for making payments to depositors are the deposit-taking institutions and no other organisation.

Amendments Nos. 5, 6 and 7 reflect the wording under the 2000 Act and work on the basis that it is the Government’s intention to set up a pre-funded scheme for the whole of the FSCS and to cover investment managers, IFAs and so on, so the contribution to the pre-funded scheme should reflect the likely level of losses that will flow from the particular classes of authorised persons.

Photo of Mark Todd Mark Todd Labour, South Derbyshire

I am sympathetic to some of the hon. Gentleman’s arguments, as I would be to the suggestion of a risk-based principle of applying a contribution. Has he considered the methodology to be applied that would produce the sums involved?

Photo of Mark Hoban Mark Hoban Shadow Minister (Treasury)

When I comment on amendment No. 6, I shall come on to risk-based premiums. That is an important issue and it is a principle that underpins the US Federal Deposit Insurance Contribution scheme whereby there is a risk-based contribution. I shall return to that in a minute.

I want to establish what types of institution will be covered by a pre-funded scheme other than banks. If other institutions will be so covered, it is important that their contribution reflects the likely level of losses that they could face in the future. A worry about cross-subsidy has emerged from our debate. We heard from the Association of British Insurers about that this week. It is worried that the present approach requires all the sectors of financial services to contribute to the cost, and that would involve a cross-subsidy that imposes an unfair burden on the insurance industry.

The ABI highlighted the case of Bradford & Bingley when insurers, as investors, made a contribution the first time round to solving the problems. That did not work, and they now have to pay potentially through the cross-subsidy route. In the debate about who would fund a pre-funded scheme, there are clearly trade bodies that consider that the onus should fall on the sector that is directly affected rather than going through the pre-funded route.

I had a conversation with the Association of Independent Financial Advisers, which recognises that there are cases when transactions have been intermediated. Obviously, the association understands the matter from its perspective—it might have put an insurance policy with a company or advised on some investment arrangement. It is therefore appropriate for there to be some form of subsidisation within a narrow part of the financial services sector, but not to the breadth that the clause, as drafted, could lead to.

Another aspect is that banks and insurers—they are well capitalised businesses in terms of banks and they will be better capitalised when the money goes in—should be seen to have the resources to contribute to a pre-funded scheme. Intermediaries are not as well capitalised and might well find it expensive and difficult to do so. They potentially might not be able to afford to contribute to a pre-funded scheme, particularly one to subsidise the entire sector, rather than just a narrow part of it.

There are some important issues in relation to who we are expecting to contribute to a pre-funded scheme. In making a contribution will they be expected to support—or cross-subsidise—other parts of the financial services sector? At the moment, the clause permits that. It would be helpful if the Minister could outline the Government’s thinking about where the parameters of the scheme are in terms of both coverage and contributions.

The hon. Member for South Derbyshire raised the issue of risk. Amendment No. 6 is a peg on which I want to hang that discussion because it makes provision for contributions to vary from person to person in a particular class. The US system—the FDIC—works on a risk-based approach. Any Member who wishes to look at the FDIC website can see that the calculation of the premium that someone should pay into the fund is based on various tests, such as the amount of non-performing loans. The proportion of non-performing loans is a factor that drives the calculation of the levy, and whether a business is well capitalised also drives the levy. The better capitalised the business is, the lower the risk of its business and the lower its contribution to the FDIC. There is clear weighting when to comes to risk. The clause does not set out whether the Government expect there to be a risk-weighted contribution. Of course, if there is a risk-weighted contribution, it is like an insurance policy in a way. We are saying that bank A has a particular set of risks and consequently should pay an amount related to its risk.

Photo of Mark Todd Mark Todd Labour, South Derbyshire

Essentially, that also reinforces the moral hazard principle, which is that if people contribute collectively to a particular resource, one does not want to effectively incentivise higher-risk behaviour by letting the individuals concerned know that they will not necessarily have to bear the full consequences of their action. Giving a clear trigger that says, “If you choose a model that has those particular features, you will bear a greater burden towards the compensation scheme,” reinforces the message about their behaviour.

Photo of Mark Hoban Mark Hoban Shadow Minister (Treasury)

Absolutely. The measure sends a clear message and imposes an additional cost on them for following those businesses practices. It says to them, “If you follow a high-risk business strategy, you will have to pay more into the fund.” That will, essentially, potentially disincentivise businesses from following that strategy. If  a business is not profitable, it will choose not to follow that route because the contributions it would have to make would exceed the profitability of the business. The measure forces businesses to think carefully about the business model they follow and its consequences for their levy. Banks that follow a prudent, cautious and conservative policy in their business development would not want their shareholders and investors to, in effect, bear the cost of the more reckless and imprudent policies that other banks might follow.

I hope I have not transgressed your rule so far, Mr. Gale. I have some reservations that I will come to much later, in the stand part debate. There are some other issues in relation to the principle of whether we should have a pre or post-funded scheme. With a pre-funded scheme there is clearly an issue with how risk is reflected in the contributions that people make.

It would be helpful for a Government who are minded to introduce a pre-funded scheme to set out what role they believe risk should play in determining the contributions to be made by members of the scheme.

To conclude my remarks on this group of proposals, four issues concern me. First, what is the scope of the scheme and what will it pay out for? Secondly, who will pay into the scheme? I have said clearly that we want the amendments to suggest that it should just be banks and building societies. Thirdly, if the scheme is broader, contributions will be made by other parts of the financial services sector and I suggest that those contributions should be in line with the likely level of future payouts. Fourthly, if a scheme such as this is set up, what role will risk play in determining the contributions?

People are interested in how the scheme will work in practice, but there is no consensus about the merits of the scheme. People want to know more detail about the Government’s thinking on this matter. The Minister’s comments will be very important in giving stakeholders an insight into the Government’s thoughts on this difficult area.

Photo of Ian Pearson Ian Pearson Parliamentary Under-Secretary, Department for Business, Enterprise & Regulatory Reform, Economic Secretary, HM Treasury 1:30 pm, 23rd October 2008

The amendments would make a number of significant changes to clauses 156 and 159. Before turning to them in detail, I will set out the Government’s understanding of the intention of the clauses. The function of the FSCS is to pay compensation to eligible claimants if financial services firms are in default and are unable to meet the claims. Funds are needed to pay compensation. The FSCS normally obtains the funds by making levies on the financial services industry. If very large firms such as banks or building societies default, the FSCS will need much more money in a short time than it could realistically raise from the industry or borrow in the ordinary way from commercial sources.

Two solutions have been put forward for that problem: building up funds in advance or borrowing money from the Government that can be paid back using future levy payments. Clause 156 allows for the first of those and will set up contingency funds in advance of need through a process commonly called pre-funding. Just to set the record straight, the Government are clear that now is  not the right time to introduce pre-funding. Clause 159 allows for the second solution with borrowing from the national loans fund. That is a technical change that allows the public sector to lend to the FSCS in the most efficient way. As the Committee knows, the public sector has already made loans to the FSCS to enable it to play its part in the transfer of deposits from Bradford & Bingley, Heritable and Kaupthing Singer & Friedlander.

Photo of Peter Bone Peter Bone Conservative, Wellingborough

The Minister says that there will be a cost for those organisations. Is it true that those costs will ultimately be charged to the banking system using the current system?

Photo of Ian Pearson Ian Pearson Parliamentary Under-Secretary, Department for Business, Enterprise & Regulatory Reform, Economic Secretary, HM Treasury

Yes, our understanding is that the FSCS is the first port of call for compensation. I am happy to confirm that.

Photo of Mark Hoban Mark Hoban Shadow Minister (Treasury)

My hon. Friend asked whether the banks will pick up the cost. Is not the reality that if the cost exceeds £1.84 billion, the excess cost will fall upon other levy payers to the FSCS?

Photo of Ian Pearson Ian Pearson Parliamentary Under-Secretary, Department for Business, Enterprise & Regulatory Reform, Economic Secretary, HM Treasury

We have discussed that point already. Obviously, if the banks are regulated by the Icelandic authorities, the first part of the compensation will have recourse to those authorities. They have a guarantee of about £16,500. Secondly, the Financial Services Compensation Scheme goes up to £50,000, and thirdly, if required, recourse would be to the Treasury. I hope that that is helpful.

Photo of Peter Bone Peter Bone Conservative, Wellingborough

I apologise to the Minister; I did not make myself clear. The question was not about top-up money above £50,000 or the money that Iceland will provide but rather about the money in between. Will that cost fall entirely on the banks and building societies, or over the wider financial community?

Photo of Ian Pearson Ian Pearson Parliamentary Under-Secretary, Department for Business, Enterprise & Regulatory Reform, Economic Secretary, HM Treasury

I am sure that we can come back to that matter at a later stage—I would be happy to do so, but first I would like to look at the hon. Gentleman’s amendments.

Amendments Nos. 2 and 8 would restrict the uses that could be made of the contingency funds. Amendment No. 2 is the more restrictive. It would mean that contingency funds could only be used to meet the expenses arising from the Banking Bill, and not for the payment of compensation for other types of FSA-regulated activity covered under the compensation scheme. Amendment No. 8 would allow the funds to be used for the payment of compensation to depositors, but not in relation to any other kind of regulated activity. Amendment No. 1 is a consequential amendment following on from amendments Nos. 2 and 8. It means that only banks and building societies could pay levies to build up a contingency fund. That would be logical if pre-funding were restricted to deposit taking.

We feel that to restrict pre-funding to deposit taking in the Bill would be unnecessary and undesirable. The Government have made it clear that there is no intention to bring in pre-funding in the near future. Clearly, the timing would not be right now, and it would not be appropriate to speculate about when it might be right or on which funds the measure might be established. It is sensible to have flexibility—we do not know what challenges the future may bring. The Bill allows for different funds to be established for different purposes and for different persons to contribute to those funds.

Photo of Stewart Hosie Stewart Hosie Shadow Chief Whip (Commons), Shadow Spokesperson (Treasury)

Notwithstanding that the time for pre-funding is not now—there is general agreement about that; we should not bash balance sheets when they are already weak—I am looking for the opposition to this in principle. Why is it wrong to restrict pre-funding to deposit takers when the time is right?

Photo of Ian Pearson Ian Pearson Parliamentary Under-Secretary, Department for Business, Enterprise & Regulatory Reform, Economic Secretary, HM Treasury

We have made it clear that if the Government considered the timing to be right, we would have discussions with the Bank of England and the FSA, and undoubtedly more widely. The powers that we seek in the Bill could potentially go further than deposit takers and banks and building societies. In the future, a scheme might allow different funds to be established with different legal entities. But pre-funding cannot be introduced without parliamentary approval and the affirmative resolution procedure. The Bill confers flexibility that can be exercised only if subject to full parliamentary scrutiny at that time.

Amendments Nos. 3 and 6 would ensure that when making regulations for pre-funding, the Treasury could specify how a levy was to be apportioned between different members of the same class of levy payer. That could make the introduction of risk-based levies by the Treasury possible—an issue that my hon. Friend the Member for South Derbyshire raised a few moments ago.

The Government consider that apportioning any levy between firms within the same class should be a matter for the FSA. The FSCS will have to raise levies under different powers as a result of the Bill, and those powers must be co-ordinated at a detailed level. The FSA is best placed to do that.

The FSA already has the power to decide the rules that govern the apportionment of levies between levy payers of the same class under the existing FSMA provisions, so it could already bring in risk-based levies if it was considered appropriate to do so.

Amendment No. 4 would limit to banks and building societies the classes of person who may be required to contribute to levies to repay borrowing from the national loans fund. In our view the amendment is unnecessary, as it would be possible to set out in the regulations which classes of person will be required to contribute to the repayment of borrowing. Perhaps more importantly, any type of financial services firm could default and if the costs of the default were large enough, it might be appropriate for the FSCS to borrow from the national loans fund, to obtain the liquidity it would need to pay compensation. If the firm concerned was not a deposit taker, it would not be appropriate for levies to be imposed only on a deposit-taker class of firm for the purpose of repaying the loans.

Amendments Nos. 5 and 7 would impose an unnecessary restriction on the making of regulations regarding the levies to build up contingency funds, or to finance the repayment of borrowing from the national loans fund. Clearly, any type of firm could default, and in principle, therefore, any class of levy payer should have to contribute to the costs of repaying of borrowing. As I have just explained, it will be possible to have different contingency funds for different purposes, and for different classes of persons to be required to contribute to different funds.

The hon. Member for Fareham raised the issue of the general retail fund and the possible introduction of pre-funding, and the mechanisms through which levy payers in one class may be required to contribute to the compensation costs of other classes. Those are separate issues, but I agree that if pre-funding were introduced, consideration would have to be given to the interaction of pools covering different types of business. I want to emphasise that this will be part of any consultation about the introduction of pre-funding. The two arrangements—pre-funding and the general retail pool—are not incompatible. Pre-funding is a way of providing the resources needed to meet the costs that fall on one class of levy payers, such as banks and building societies. A contingency fund could be used to meet compensation costs that a class of levy payer has to bear, whether those costs originated in that sector or elsewhere. Equally, the existence of a fund could reduce the extent to which levy demands spill over on to other sectors.

If regulations for pre-funding or NLF borrowing were made, we would ensure that the appropriate class of levy payer had to be the primary contributor towards the levy concerned. I entirely agree with the general principle that each sector should consume its own smoke, but this is yet another point where flexibility is important, and in the Government’s view it would be better not to tie our hands too much for possible future circumstances that we cannot anticipate at this stage.

I hope that that will give the Committee the assurance it needs on this issue. It is worth remembering that any regulations the Treasury makes will be subject to parliamentary scrutiny, through either the affirmative or the negative procedure. I am confident that any unsatisfactory allocation of levies would be speedily challenged.

Photo of Peter Bone Peter Bone Conservative, Wellingborough

I understand why the Government want flexibility, but the affirmative and negative procedures only allow the regulations to be accepted or rejected; they do not allow them to be amended in any way.

Photo of Ian Pearson Ian Pearson Parliamentary Under-Secretary, Department for Business, Enterprise & Regulatory Reform, Economic Secretary, HM Treasury

We made clear our intention that when it comes to pre-funding, we would want to consult widely before drawing up secondary legislation, not just by consulting the FSA and the Bank of England, but by undertaking a more formal consultation exercise. The issues and concerns would be raised during that process. As I said, I think that the general principle that each sector should consume its own smoke but that we must allow flexibility because we do not know what the future might bring, is the right one. I hope that I have convinced the Committee of that case.

Photo of Peter Viggers Peter Viggers Conservative, Gosport

I was listening to the Minister’s speech to hear whether he would explain, if there are to be differential rates of levy, how people will perceive an institution that is subject to them. Will  those rates be ascertainable through a central register, or will the individual institutions be obliged to bring them to the attention of their customers, to allow them to take account of the risk that the differential rate implies? I have not heard that point made and I should be grateful to be reassured and have an an explanation.

Photo of Ian Pearson Ian Pearson Parliamentary Under-Secretary, Department for Business, Enterprise & Regulatory Reform, Economic Secretary, HM Treasury 1:45 pm, 23rd October 2008

As I argued earlier, the FSA already has the powers, if it considers it appropriate, to introduce differential rates. It is a matter for the FSA, which in its normal way would want to consult parties if it were to take any future action, and I do not think it appropriate for us to accept the amendment.

Photo of Mark Hoban Mark Hoban Shadow Minister (Treasury)

Frankly, I was not at all impressed by the Minister’s response to this debate. I quite like the Minister and last week we had a good debate about another Bill, and he provided some good responses to points made during that scrutiny process.

The Government have included in the Bill a wide-ranging power to set up a contingency fund. The debate up to today has focused on whether that should apply to the banking sector. I was hoping that we would hear from the Minister a clear statement that that was the extent of the fund. That is why I tabled these probing amendments. It now becomes clear that the Government are taking powers that will enable the FSCS to introduce pre-funding to cover not just bank depositors but any aspect of regulated financial services activity, and that any regulated financial services company can contribute to the fund in whatever way it believes to be right at the time. Amendments Nos. 5 and 7 reflect the wording in the Financial Services and Markets Act 2000. The current scheme works according to that wording—it is nothing new. It seems odd to have an approach to levies that relates to an existing pay-as-you-go scheme when there may be a different form of levy for contingency funding, and when the Government will want flexibility with regard to contributions relating to the likely risk of future claims in that sector.

Cross-subsidy is a big issue in this debate. That is why I pressed the Minister when he began his remarks about the current problems that face us. The reality is that if the claims on the FSCS in respect of the banking sector exceed £1.4 billion, that cost will be borne by other financial service companies.

Photo of Mark Hoban Mark Hoban Shadow Minister (Treasury)

£1.8 billion. I have spoken to various people in the financial services sector—banks and non-banks—who are concerned that that might happen. The FSCS is paying interest on the amount of money linked to the transfer of Bradford & Bingley accounts to Banco Santander. It is picking up the gap between the £16,000 and £50,000 limit in relation to the Icelandic banks. There is genuine concern in the sector that IFAs, insurance brokers, insurers and fund managers will have to pick up the excess if those costs exceed £1.8 billion. I wonder why the Minister did not accept that point when I intervened. It worries me that the Government are not on top of the cross-subsidy issue, which is at the heart of a series of amendments in this group.

Photo of Mark Todd Mark Todd Labour, South Derbyshire

There are two forms of cross-subsidy that we could be concerned about. One is between wholly different activities within the financial services sector, and I understand the hon. Gentleman’s argument on that. The second is between different business models within the same class of activity, which is another potential difficulty. I was not entirely clear from the definition in the Bill whether there is the opportunity to distinguish within classes of activity. The Bill allows a distinction between classes of activity, which presumably would refer to banks, building societies, IFAs and insurance companies, but not on the basis that a particular activity carries inherently higher risk and therefore should be distinguished in a different way.

Photo of Mark Hoban Mark Hoban Shadow Minister (Treasury)

In a sense, that is partly addressed by whether a risk premium is attached. Again, the Minister will say that that is a matter for the FSA and that there will be a consultation, which I did not think was a robust answer because the issue is important.

I will come on to the stand part debate on clause 156, which concerns the impact that pre-funding could have on building societies compared to banks—a point that Adrian Coles made to us on Tuesday. A pre-funded scheme gives rise to many issues which have not been properly addressed.

Photo of Ian Pearson Ian Pearson Parliamentary Under-Secretary, Department for Business, Enterprise & Regulatory Reform, Economic Secretary, HM Treasury

I have made it clear to the hon. Gentleman that the pre-funding issue and the powers that we seek potentially go beyond banks and building societies. His amendments seek, principally, to limit the provisions to that, which is why we are inviting the Committee to reject them. However, I confirm that we accept the general principle that institutions should consume their own smoke.

On cross-subsidy, it is in the general interests of financial stability, which all financial services firms benefit from, that they should contribute and provide to a scheme. It is therefore right that the generality of financial services schemes should contribute where costs to deposit takers are likely to be above £1.8 billion per annum.

Photo of Mark Hoban Mark Hoban Shadow Minister (Treasury)

I do not think that there has been a satisfactory explanation as to why the Government oppose our amendments. These powers give the Government wide discretion to set up a type of scheme that they feel is appropriate at the time, in a flexible way, but the Bill does not give safeguards to the financial services about how the powers would be used in practice. On that basis, I want to press amendment No. 5 to a vote because it tackles the point that the level of contribution to a pre-funded scheme should reflect the likely level of contribution that will be made.

That does not preclude an element of cross-subsidy, but reflects the basic principle on which contributions to the scheme are made, as set out by the 2000 Act. It reflects that wording clearly, and if the Government are to introduce a pre-funded scheme, people should be aware of the type of funding mechanism that will be used, rather than leaving it to be flexible.

I beg to ask leave to withdraw the amendment.

Amendment, by leave, withdrawn.

Photo of Roger Gale Roger Gale Conservative, North Thanet

We will come to amendment No. 5 at the appropriate point.

Photo of Mark Hoban Mark Hoban Shadow Minister (Treasury)

I beg to move amendment No. 36, in clause 156, page 81, line 20, at end insert

‘and ensuring that no such investment shall cause there to be a prevention, restriction or distortion of competition in the relevant lending market;’.

The amendment deals with the way in which money that has accumulated in a pre-funded scheme should be invested. Concern has been expressed to me about the potential distortionary impact that a fund might have depending on how much has built up within it, and about its impact on the wider savings investment market. Will the Minister clarify how he thinks that the fund will be invested in the future? What comfort can he give that it will not be invested in a way that leads to distortion?

Photo of Ian Pearson Ian Pearson Parliamentary Under-Secretary, Department for Business, Enterprise & Regulatory Reform, Economic Secretary, HM Treasury

The Government believe that the amendment is unnecessary. If pre-funding is introduced, our intention is that the contingency funds built up would be invested in the national loans fund, as is provided for in clause 158. Funds invested in the NLF will have been lent to the Government and will be used to minimise Government borrowing. At the end of each day, the Exchequer must borrow from, or place funds on deposit with, the money market depending on the net position after balancing outflows in order to finance expenditure again. Any funds from the Financial Services Compensation Scheme will represent an inflow and arrangements will be put in place to minimise the impact of the flows and ensure that there is no distortion of money markets.

The purpose of proposed new section 214A(2)(f) is to enable the regulations to specify some of the detailed requirements on NLF investors. Proposed new section 223A(2) in clause 158 allows the Treasury to agree terms and conditions with the FSCS from the borrower’s point of view. The FSCS is an independent body so will have to contract with the Treasury, like any other lenders to the Government. We need to be able to regulate both sides of the transaction and equally, of course, to keep both sides separate in our minds. There is no intention that new section 214A(2)(f) would be used to require the FSCS to take a different approach from that set out above to the investment of contingency funds, but of course were that to be proposed in the future, parliamentary approval would be required under the affirmative resolution procedure. We could then build in safeguards to meet concerns about distortion at that stage. I hope that that clarifies the point for the hon. Gentleman.

Photo of Mark Hoban Mark Hoban Shadow Minister (Treasury)

I am grateful to the Minister for his response, which clarifies the matter put to me. On the basis of that reassurance, I beg to ask leave to withdraw the amendment.

Amendment, by leave, withdrawn.

Amendment proposed: No. 5, in clause 156, page 81, line 27, at end insert—

‘(2A) In making any provision by virtue of subsection (2)(c) the Treasury must take account of the desirability of ensuring that the amount of the levies imposed on a particular class of authorised person reflects, so far as practicable, the amounts of claims made, in respect of that class of person.’.—[Mr. Hoban.]

Question put, That the amendment be made:—

The Committee divided: Ayes 5, Noes 7.

Division number 1 Nimrod Review — Statement — Clause 156

Aye: 5 MPs

No: 7 MPs

Ayes: A-Z by last name

Nos: A-Z by last name

Question accordingly negatived.

Question proposed, That the clause stand part of the Bill.

Photo of Mark Hoban Mark Hoban Shadow Minister (Treasury) 2:00 pm, 23rd October 2008

Even if I did not object on principle to pre-funding, I would still object to the clause because, in response to the previous group of amendments, the Minister did not give us sufficient reassurance about how it will be used in practice or about its scope. It is broadly drafted and gives the Government the flexibility to do pretty much what they want in a pre-funded scheme on the back of an affirmative resolution. That does not give security or confidence to the wider financial services sector.

Notwithstanding that fact, I have an objection of principle to a pre-funded scheme. There has been quite vigorous debate since last October about the merits of a pre-funded compensation scheme. There are arguments why one might be appropriate. One example is that it would not be pro-cyclical. If there was a large default by a bank now, banks would have to contribute through the levy, at a time when their capital was under pressure. Clearly that would exacerbate the current position. The argument is that under a pre-funded scheme a contingency fund would be available to absorb those losses rather than increasing the levy at a time when banks are in difficulty.

The Governor of the Bank of England, who is supportive of a pre-funded scheme, said that

“if you wait until there is a problem, that’s a pretty bad time to ask banks to put up a large amount of money”.

That is not an unreasonable comment. I accept that, which is why we support clause 159 in principle. It would enable the scheme to borrow from the national loans fund. However, on balance there are some stronger arguments against a pre-funded scheme. We believe that any assets held by the fund would be better deployed by the financial services sector as a whole—not just by the banking sector but by insurers, IFAs, investment managers and all the people who could be subject to a contingency fund. It would be better if they retained their own capital and determined how to deploy it rather than having possibly significant sums locked up in a pre-funded scheme.

The Government have not given a clear indication about the period over which a scheme would be built up. Would it be over two, three, 10, 15 or 20 years? How much would institutions have to contribute over what  period of time? Clearly, the quicker the build-up of a fund, the greater pressure financial institutions would come under as a consequence of contributing to it. That is a concern.

In the United States there is a pre-funded scheme. We had a discussion earlier about the FDIC. There is a different banking model in the US, compared with the UK. Like the hon. Member for Sedgefield, I was in the States in the summer. I drove past the First National Bank of Collinsville, which had just one branch—in Collinsville. It was to be covered by the FDIC. I asked the Congressmen I was with whether they did not think it a risk having an account with such a bank. They replied that as long as they did not put in more than $1,000, they would be okay because they would be covered. That shows the fragmentation in the US banking market. There is a much greater expectation of banks failing, because they are smaller, less well capitalised and more prone to default.

There is another reason why we do not believe that pre-funding is necessary. The important thing in the event of a default is ready access to cash. We need ready access to cash for depositors, but the FSCS needs ready access to cash too. It has to have access to that liquidity, which is why the facility available under clause 159 is so important. It gives the FSCS access to liquidity. If we had a pre-funded scheme we would not know, when the balances were being built up, at what point there might be a bank insolvency and whether there would be enough money in the scheme. If there was not enough money in the scheme, we know that the FSCS could draw on liquidity from the national loans fund. There is no fundamental requirement that suggests to me that we must have a pre-funded scheme, as long as there is access to loans from the national loans fund.

One of the messages that came across in our discussions on Tuesday was the absolute necessity for ready access to cash, but that is different from the desirability or otherwise of a pre-funded scheme. Indeed, Nigel Jenkinson, the director of financial stability at the Bank of England, said that pre-funding was “not necessary, but desirable”. There is a very important distinction to be drawn.

Although there may be consensus among some people that a pre-funded scheme is desirable, there is certainly no such consensus in the banking sector. I have the impression that the Building Societies Association is not sold on the idea either—Adrian Coles, speaking in the evidence session on Tuesday, was very explicit about that. Let us not forget that the BSA scheme has not been a failure; it has always looked after its own and it has always swallowed its own smoke, to use the Minister’s phrase from earlier.

Adrian Coles said:

“There is a choice of whether to put it in the compensation scheme to protect depositors, or whether to keep it in the building society balance sheet. At the margin, if the money is taken out of the building society and put in the compensation scheme, depositors...are slightly less safe by the amount that the building society has given to the compensation scheme.”——[Official Report, Banking Public Bill Committee, 21 October 2008; c. 44, Q122.]

That demonstrates that we must think through the economic analysis of the issue. Adrian Coles went on to say that

“if there were a requirement for pre-funding, and if there were a requirement to keep capital at the current level in building societies, the only place the money could come from is higher mortgage rates or lower saving rates for building society customers.”——[Official Report, Banking Public Bill Committee, 21 October 2008; c. 47, Q131.]

An economic cost is attached to a pre-funded scheme. Adrian Coles talked about it in the context of building societies.

Photo of Sally Keeble Sally Keeble Labour, Northampton North

I am grateful to the hon. Gentleman, because he is quoting from answers to the questions I asked in the evidence session. Does he agree that one of the issues that the building societies pressed closely was risk-related premiums, because of their perceived lower risk of failure?

Photo of Mark Hoban Mark Hoban Shadow Minister (Treasury)

Indeed. I thought the hon. Lady’s line of questioning on Tuesday was very fruitful, and showed the experience that she and her hon. Friend, the hon. Member for South Derbyshire, have gained from the Treasury Committee. She put the finger on the very point: yes, there is a cost to the building society from putting money into a deposit protection scheme. However, it goes back to our previous debate about risk weighting. If a sector has a lower risk, should it contribute less to a pre-funded scheme? We talked about that in the context of different institutions when we were discussing amendment No. 6. Equally, different business models have their own consequences. The more cautious approach that building societies traditionally adopt leads to a lower risk of default in the building society sector.

The Minister whispered, “Bradford & Bingley”. As I am sure he knows, Bradford & Bingley was a demutualised building society that was swallowed up by a former building society, Abbey, which is now owned by Banco Santander. Bradford & Bingley and some of the other demutualised building societies took a very different model from that of the building societies currently in the building society sector.

Photo of Sally Keeble Sally Keeble Labour, Northampton North

May I put to the hon. Gentleman a point that it was not possible for me to put to the institutions on Tuesday? There is public concern, and the public interest would probably be in favour of a pre-funded scheme, because of people’s concerns about the general behaviour of financial institutions, precipitating some of the crises.

Photo of Mark Hoban Mark Hoban Shadow Minister (Treasury)

I am not sure that I agree with the hon. Lady. This is probably where we part company on this matter. I think people will want to know that in the event of an institution becoming insolvent the compensation scheme has ready access to cash. That is the necessity that underpins the measure. We would not want to get into a situation where consumers believed that because the fund has only built up £1 billion, for example, that is all there is in the kitty. We have not really addressed what size the kitty might be to provide protection.

Photo of Mark Todd Mark Todd Labour, South Derbyshire

How long is a piece of string? [Interruption.]

Photo of Mark Hoban Mark Hoban Shadow Minister (Treasury)

I am happy to give way if an hon. Member wishes to intervene.

The issue we are teasing out through this process is how big is the fund and how much do we need to put away? The conversation during the evidence-taking session on Tuesday suggested that it could be between £10 billion and £15 billion. The level of bank deposits earlier this year, when I was looking closely at the matter, took us as far as the 10th-largest institution. That was before the wave of consolidation over the past few months. We are talking about building up a significant fund just for banks, let alone the other sectors of the financial services industry that might have to contribute to a pre-funded scheme.

Photo of Peter Bone Peter Bone Conservative, Wellingborough

I take a slightly different view from my hon. Friend. As he said, we are talking about not wanting to reduce the capital in respect of building societies. In the case of the banks, that would mean paying out less dividend each year. That would actually be a charge on a person’s account and would build up over the years. An institution that failed would, for a number of years, have been contributing to that fund. Under the present scheme, a bank that fails does not contribute, because it has gone bust by that stage.

Photo of Mark Hoban Mark Hoban Shadow Minister (Treasury)

My hon. Friend makes a valid point. It is one of the arguments that people could deploy in favour of a contingency fund. Of course, that depends on people’s expectations and whether banks fail in future. Until recently, we had not had a run on a bank since Overend and Gurney in 18-something or other. We hope that this is an unusual time and that it will be some time before we have a crisis on a comparable scale. The Governor of the Bank of England said in his speech in Leeds earlier this week that this was the closest that we have been since the first world war to a banking collapse. We could end up with a fund of between £10 billion and £15 billion sitting on deposit somewhere for another 80 years before it was required.

My hon. Friend mentioned a pre-funded scheme enabling an insolvent bank to contribute up front to the costs of its recovery, but that would be at a cost to shareholders or potential borrowers as the costs of capital rose, because of the way in which the scheme was to be funded.

There are important arguments against a pre-funded scheme: it is expensive, it is, we hope, unnecessary and it does not address the main point, which is that we must have cash available to meet the relevant needs if a bank becomes insolvent. Dr. Huertas, in his evidence on Tuesday, made the point that

“the deposit guarantee promise needs to be backed by the full faith and credit of the Government” and that having a contingency fund would not be the full answer to the problem. He continued:

“If it ever got to the point that the deposit guarantee promise was limited to the size of the fund, the exhaustion of the fund and the removal of any type of deposit guarantee for the remaining depositors would be a severe threat to financial stability.”——[Official Report, Banking Public Bill Committee, 21 October 2008; c. 33, Q96.]

Even if the Government take the route of introducing the fund, it is not an answer in itself and is not sufficient to create financial stability. It is, in effect, a means of paying up front for the potential costs of insolvency.

Loretta Minghella of the FSCS said that it is crucial that there is always a backstop and that people are confident that the Government will always be there for the scheme.

I have talked a lot about the banking sector and how it might be affected by a pre-funded scheme. My contention is that as long as there is access to the national loans fund, that will create the liquidity that the scheme needs to repay depositors. Then, we can look at recovering the amounts from the levy payers over a reasonable period, so that we do not exacerbate the pro-cyclical tendencies that we might see if we asked the levy payers to pay immediately after the collapse of a bank. If we spread the repayments from levy payers, the burden would not be unfair, and they would pay only when a collapse has taken place.

I would like to deal now with what happens to others if there is a pre-funded scheme. In the insurance sector, given the nature of the impact of a collapse or an insolvency, the FSCS often pays out over a long period. Therefore, one argument from the insurance sector is that it pays out on long-term liabilities currently under the FSCS, so why should it pre-fund that scheme? If an insurance company that pays annuities becomes insolvent, the FSCS will pay out, over a long period, the compensation that annuity holders are entitled to, without having to go down the pre-funded route. The insurance sector is used to the idea of paying liabilities out over a long period. If insurers can do that, why can banks not do it?

The case has not been made for a pre-funded scheme. We could continue on a pay-as-you-go scheme, as long as there is a commitment to provide liquidity to the FSCS when necessary. Under the Bill, the powers are not sufficiently circumscribed to give people confidence in the shape and nature of a pre-funded scheme in the future.

Photo of Mark Todd Mark Todd Labour, South Derbyshire 2:15 pm, 23rd October 2008

Briefly, the case has not been made for introducing a pre-funded scheme now. It has been made for having provision for a pre-funded scheme in the future, which is why I endorse the clause. The Treasury Committee unanimously took that view when it considered the issue. However, the debate has highlighted weaknesses in the drafting of the clause. I would have welcomed a clearer explanation from the Minister of exactly how the powers will be exercised by the Government, and I hope that the debate will have given the Minister and his team the opportunity to reflect further on the approach that is being taken.

In another forum, I had the opportunity to listen carefully to the points made by the building society sector, which makes provision of its own and is assisted by the enabling legislative framework under the FSA. As an account holder with the Derbyshire, which is about to be dragooned—quite correctly, for the foolish acts of some of its executives—into the Nationwide, I know that the FSA is effectively able to force the bride and groom together with its existing powers. It is doing the same with the Cheshire and there are rumours that it will do the same with another society as well. I can well understand the attitude of the building society sector. It would say that it was being asked to cough up for something that has not happened in the past and, based on the existing legal framework, is most unlikely  to happen in the future, unless the Nationwide—now by far the largest building society—finds itself in difficulty and it cannot do the rescue operations that it has been asked to do in such cases.

The Government do not appear to be uncertain about the principle. I think that they agree about the potential need for such a fund, but my continuing concern is that they have not worked out terribly well how it would work. As for the issue of scale, I asked jokingly, “How long is a piece of string?” It is a long piece of string, but there is no attempt to quantify accurately the purpose of the fund, if pre-funded, and what its scale should be in proportion to its purpose. It would be helpful in our discussions to have a clearer definition of the fund and of its linkage to its real purposes. We all know that, if a major institution went down, it would be a useful part of a solution but no more than that.

My line of questioning in our earlier discussions highlighted the fact that a risk-based analysis is required to justify payments in; in fact, such analysis is required to justify payments at all. In other words, there is a material risk in certain areas of activity, when pre-payment may be justified, but there might be others when no such provision need or should be made. The hon. Member for Fareham’s point about the impact on some businesses from pre-funding was well made. There is not necessarily an argument that money set aside for that purpose would be better used there than in the balance sheets of the operations concerned.

However, there are some exceptions to the rule, when a pre-funding mechanism might well be a further indicator of the need for greater care in the management of a particular area of financial services and for reinforcing the message of compliance with safer, more prudent business models than have been followed until now. I noted the guffaw at my vote in the previous Division. My purpose in Committee is not to defeat the Government, but to help them to improve the Bill as far as possible and I hope that my remarks have helped me to go further in that.

Photo of Colin Breed Colin Breed Shadow Minister, Treasury

Without repeating what I said this morning, the provision is another example of the fact that trying to reconstruct an old way to address current problems is almost impossible. When the compensation scheme was set up, it was more or less envisaged that a small operation somewhere in the sticks through the stupidity of its policy might create a difficulty for some depositors and the large banks, with a view to trying to maintain basic confidence in the banking system, would each dip into their pockets for a relatively small amount to bail out the depositors, after which everyone would be happy and off we would go. It was not envisaged that that would need to be pre-funded because the amount likely to be required would be relatively insignificant to the larger banking institutions that would be required or called on to fund it.

To turn that easy and simple scheme—not pre-funded, but secure—into a scheme designed to bail out the depositors of an enormous bank, which, through acquisition and merger, has got into the situation that we are now in seems totally impossible. Yes, pre-funding  might be a great idea but, if we are to be true to it, the moneys that might be required are phenomenal. If the Government have to stand behind the shortfall—if a big bank goes down, there will be a shortfall—we might as well recognise the situation from the front end.

The Treasury Committee’s report on this issue is very good. It says that there is not much consensus on the whole thing. Obviously, the banks are not keen to put huge amounts of money into a pre-funded scheme, particularly those that think they will never have to rely on it. They wonder why they should support their competitors. It was never considered, under the old scheme, that the small institutions that might fail were competition for the big might of Barclays, the National Provincial or National Westminster banks, as they were then. They were relatively small licensed deposit-taking institutions and smaller building societies, and everything could be covered without too much of a problem. To try to turn that into something that will address the current problems is somewhat foolish.

The sensible conclusions that the Select Committee reached in its report related to the idea that, if the Government are to go ahead with the scheme, they should set a timetable. That is not a bad idea, but we have not seen one yet. People might suggest that we should not go to banks that are in a difficult situation and ask them to put large amounts of money into a pre-funded scheme, but we could get on that road. After all, we often say to people who are in large debt that they should start to save a little bit somewhere. It certainly would not be a bad idea, if we are to have some sort of pre-funded scheme, to have an idea of how the pre-funding would work and a timetable on the milestones that we are trying to reach by a certain time.

The scheme will always be subject to the vagaries of the market. The FSA might sometimes say, for example, that the levies will have to go one year because there has been some problem in the international markets. UK deposits, as a percentage of the total liabilities of the bank, will be quite small. A major problem in one part of the bank, which is nothing to do with basic banking, could trigger its failure. We have seen that happen. Only last week, a French bank had a problem after a couple of its employees risked something on the market and lost about £800-odd million.

The future risk will not be from big financial issues such as that. It will be from fraudulent or unauthorised operations, in a computer-based trading situation, that might trigger the demise of a large bank. We saw that with Leeson and Barings—that was relatively small—and we could see something like that again. In such a case, almost any amount that is placed in a pre-funded scheme is fairly unlikely to be much more than a percentage of the total payout.

If the Government are to provide that security, why should not we cut out the major banks and say to the general public, “If you want 100 per cent. certainty on your money, stick it into National Savings. Stick it into the Government in the first place, because we could use the money quite well. If you want to go to a bank—you might consider a large bank to be 99.9 per cent. certain—you might get a slightly better rate and you can go there.” Frankly, it is up to the banks to sort out for themselves how to cover their compensation scheme.

Photo of Colin Breed Colin Breed Shadow Minister, Treasury

In a moment. I understand the consumer aspect, but the banks have to shoulder the responsibility of maintaining confidence in banks. If the banks come a cropper, the banking industry has to pay for it. The banks should not seek recourse to the taxpayer.

Photo of Sally Keeble Sally Keeble Labour, Northampton North

The hon. Gentleman seems to be saying that no effort should be made to get the banks to consider pre-funding, and that the Government should simply provide the backstop. Actually, it was about the Government providing liquidity, not paying the bills. Does he accept that there is an extreme moral hazard in that position, because there would be no incentive on the banks to try, because they would know that the Government would simply cough up to the public?

Photo of Colin Breed Colin Breed Shadow Minister, Treasury 2:30 pm, 23rd October 2008

I am sorry if I have confused the hon. Lady, but the case is the reverse. I see no sense whatever in giving the large commercial banks confidence that the taxpayer will come to their aid, so the depositor can actually make a clear decision. We ought not only to re-emphasise support for the demutualised sector in a more modern context, which is a better model for much domestic lending, but give people more opportunity to put their hard-earned savings, particularly up to £50,000, into a clear and reasonable national savings operation that would give them 100 per cent. security. If they want to go out to the market, they take whatever they perceive to be the potential risks of doing so. Otherwise, we will always have to be the lender of last resort, which could be very expensive in the future.

Photo of Peter Bone Peter Bone Conservative, Wellingborough

I must be misunderstanding this. Is Liberal Democrat policy now that people who put their money into banks have no deposit protection?

Photo of Colin Breed Colin Breed Shadow Minister, Treasury

No, at present, we support the scheme as it is put down. I am just saying that I do not believe that the scheme will be fit for purpose in the future. We have to decide how and when the taxpayer can genuinely underpin the sort of potential liabilities that the large banks will present us with.

When we had a multiplicity of much smaller banks and a vibrant building society sector, it was much easier to put together a compensation scheme that would be funded mainly by the banks and might require a small amount from the Government at some stage. That is not the case today. We have large institutions that are subject to some extreme policies, as we saw with Northern Rock, and are allowed to go far beyond the usual, prudent way. They are subject to all sorts of problems in computer-based trading operations in a market that moves extremely quickly and in which banks can both make and lose an awful lot of money.

Unless we have massive capital requirements, which would be internationally uncompetitive, or require a massive amount put into some pre-funded schemes, there will inevitably be recourse to the taxpayer to provide that sort of assurance. I am quite happy to go along with what we are trying to do because today’s circumstances require it, but I hope that the FSA and the Treasury will look again at how we can genuinely ensure that people get some sort of protection.

As soon as the Government indicated that they would stand 100 per cent. behind the banks, people put their money into something they thought was 100 per cent. safe. Why are we so shy about that? I see no reason why we cannot promote a much more vigorous national savings opportunity so that people can get a reasonable rate of interest with that absolute assurance. They can go outside that if they want to and look at some of the large banks that in general terms have no great difficulty in supplying such rates, but if we are to go through some compensation scheme that will stand behind large amounts, the situation is not satisfactory.

Photo of Peter Bone Peter Bone Conservative, Wellingborough

It is a great pleasure to follow the hon. Gentleman because his thinking is out of the box and he has real concerns about the whole scheme, which is useful for the debate.

I have a problem supporting the clause. My hon. Friend the Member for Fareham made the good point that people are concerned about whether they will get their money. It is rather like the ABTA scheme: customers do not worry about how it works because if their travel agent goes bust they know they will get the money. That is the bit that people really want to know.

I have particular concerns about the clause because it contains the wonderful phrase:

“The Treasury may make regulations”.

When I see that in a Bill I think, “Aha! The Government are not telling us what they want to do and are hiding it for later on.” That is clearly the case here. A free-funded scheme that we do not know will work might disadvantage the banks in the international scene. If we create a fund that is not adequate and which, in financial terms, puts our banks at a disadvantage against their competitors, there is probably no point in doing it. People outside the Palace of Westminster will be concerned about one issue: they see the banks arrive at this crisis having got away with murder, and because the Government are not putting money away for a rainy day or for when a bank fails, people may perceive that the banks will be off again taking big dividends and giving excessive salaries to executives.

Photo of Mark Hoban Mark Hoban Shadow Minister (Treasury)

But does my hon. Friend recognise that there are other ways of tackling the issue? It can be tackled through improved regulation such as the macro-prudential regulation that our party has talked about. If a bank goes bust, the people who lose their money are predominantly the investors. They will be encouraging banks to adopt a more cautious and prudent approach, so that they do not lose their investments. Other checks acknowledge that there is a cost to following reckless policies. Moving to a pre-funded scheme is not the only way to stop banks behaving irrationally.

Photo of Peter Bone Peter Bone Conservative, Wellingborough

I am grateful to my hon. Friend for that intervention. That point would have been the conclusion of my remarks—there must be other ways for us to get the point across to the public that things are being controlled. I looked at the share-placing agreement for the capital that taxpayers are investing in banks. It contains a clause that deals lightly with the emoluments of directors. That could be strengthened. There are other ways of proceeding, so given the way that clause 156 is drafted, especially those wonderful words,

“The Treasury may make regulations”,

I am afraid that I cannot support it.

Photo of Sally Keeble Sally Keeble Labour, Northampton North

I have a few brief comments. The clause and the proposed new section go to the heart of the issues in the Bill, especially those about building public confidence in our banking system. I strongly support the Bill as it stands. It may be thinking out of the box, but some of the proposals suggested by the hon. Member for South-East Cornwall do not deal with the current pressures facing the banking system. It is not realistic to say that if people want to be confident of their savings, they should put them into national savings. Retail banking is one of our most successful industries, and it is important that the public have confidence and feel able to invest their savings in it, and in national savings, should they want to. We must ensure that the public and institutional investors have confidence and in this instance, the Government have a responsibility to the broad mass of people who want somewhere safe to put their savings.

Photo of Sally Keeble Sally Keeble Labour, Northampton North

Part of what we are looking at now, and some of the wider regulations that the Government are looking at, deal with precisely such issues. If the public are to have confidence, they must know that arrangements are in place for when things go wrong. Those arrangements must cover more substantial difficulties than we have seen previously. That is what the provisions are about.

Perhaps the hon. Gentleman should look at the evidence given by the Governor of the Bank of England about the different models for financing such schemes—they were either insurance-based or pre-funded. At the time, the Governor supported a mixed model, but he certainly accepted an element of pre-funding.

We have moved on since the Governor gave evidence to the Select Committee, and it seems that there is a public issue about the way that financial institutions have operated. Both general logic and the public require that people who might have a role in causing major losses to the general public as well as to the economy, should make some provision for, or be seen to contribute to, clearing up the mess. That is partly what contingency funding is about.

Photo of Colin Breed Colin Breed Shadow Minister, Treasury

I entirely agree with that. What I am saying is that the original scheme had no recourse to the taxpayer. It was never even considered that it would be necessary. I want the scheme, as far as possible, to have no recourse to the taxpayer, whether that is achieved through massive pre-funding or some sort of amazingly risk-based premium insurance. The scheme is largely to do with the banks and the institutions looking after themselves. If it is almost inevitable that it will come to the taxpayer, I am not happy.

Photo of Sally Keeble Sally Keeble Labour, Northampton North

I completely agree that the call on the public purse should be as small as possible, given that, in a sense, there is a failure of the private sector. The Government backstop for a pre-funded scheme would be to provide liquidity. It would not necessarily be to pick up the costs, because there would be the assets from the failed bank and issues about loans and repayment. It is important that there are visible, up-front contributions and that thought is given to how the banking industry will deal with possible failure. That is partly what the argument—the pre-funding—is about.

We have heard different scales for the contributions that might be needed, and an indication—from the Governor, I think—that if a fund is to be built up in any reasonable way, the contributions have to start early. We are not talking about the Government backstop being a blank cheque written by the taxpayer to bail out the banking industry, as was clear in the evidence on Tuesday. We are talking about provision of liquidity that is likely to be temporary, pending the arrangements made around a bank failure. The hon. Member for South-East Cornwall may say that was not needed previously, but we did not think that HBOS would get into difficulties; all kinds of things have happened that we did not think possible. We have to recognise that the scheme has to deal with a different order of events, and a different banking world from the one we were used to and which we might like to inhabit. Unfortunately that world has gone. Those changed circumstances require something more substantial and it is right that it should be done by regulation.

In essence, the provision is a reserve power that can be called on to introduce the scheme, and then some of the details will be worked out. There are two reasons for that. First, it was clear in the evidence given on Tuesday that some complex risk-based premium issues need to be looked at and, given that the Governor thought that a hybrid scheme was possible, that issue too needs to be looked at. We also need to consider the scale of the different institutions and how the payments are structured. I absolutely would not want a scheme that let the guilty parties off the hook. I completely take on board the point made by the hon. Member for Wellingborough about not wanting to bring in general sweeping regulation. However, we are acting now because we need confidence in the banking system, so we cannot say, “Okay, we’ll do all the rest and then some way down the line we’ll think about this particular thing.”

Photo of Mark Hoban Mark Hoban Shadow Minister (Treasury) 2:45 pm, 23rd October 2008

Is not the reality that although the Government will have the powers to introduce a scheme, there is a clear expectation that it will not be introduced now? The hon. Lady wants certainty now, but the reality is that these are enabling powers, not actual powers.

Photo of Sally Keeble Sally Keeble Labour, Northampton North

I completely take the point, but the inclusion of the powers in the Bill now, puts my constituents in a position to say, “This is what the Government can do; this is what can happen.” They can see that provisions are in place and that we will not get into a further crisis some way down the line and have to come back with primary legislation, which takes so long, and start to look at setting up such a scheme.

It is a difficult situation because we are trying to deal with changed circumstances, scales of losses that we had perhaps not previously expected, and the real complexity of how the structures of the scheme might work. On the contribution that the banks might make, even the Governor of the Bank of England had to be pressed and pressed when talking about, as I recall it, non-negligible billions. We need to say now that we are prepared to give the Government the powers to introduce a pre-funded scheme so that we can make sure that, in consultation with the industry, we can give the public of this country the best possible assurance that if they put their money into a bank, their interests will be protected. We need to give that to people now and the clause is key to doing so. That is why I strongly support it.

Photo of Ian Pearson Ian Pearson Parliamentary Under-Secretary, Department for Business, Enterprise & Regulatory Reform, Economic Secretary, HM Treasury

So there we have it. The view of the official Opposition is that they are, in principle, against asking banks up front to pay some money in case of the possibility of future banking failures. In fact, the hon. Member for Fareham went further, and said that even after failure, they should be spreading the burden over a number of years. I have to ask him and the official Opposition, “Have you been listening to what ordinary people are saying?” I do not think that they can have been listening.

It is absolutely right that we take the powers in the clause and accept the principle of pre-funding. We made it clear that now is not the time to introduce a pre-funding scheme. In some of the debate that we have had earlier, we have been trying to design the scheme, but now is not the time to do that; now is the time to say that as a matter of principle, we think it is right that pre-funding should be introduced at some time in the future. We should talk about the practical details and having a risk-based approach to making contributions, as mentioned by my hon. Friends the Members for South Derbyshire and for Northampton, North, who made an excellent contribution to the debate. However, we can do so when we debate how pre-funding might be introduced in the future. We do not need to make provision in the Bill for risk-based levies because the Financial Services Authority already has the power, but I agree that it is something to be considered, if a pre-funding scheme should be introduced.

On building societies, I want to briefly say that large parts of the Government’s proposals in the Bill for the special resolution regime will ensure that the Government can resolve banks and building societies through private sector solutions. That will avoid the recourse to compensation in the first place, which clearly must be our last resort.

I was not clear about the official position of the Liberal Democrats on this matter—whether they are favour of pre-funding.

Photo of Colin Breed Colin Breed Shadow Minister, Treasury

We are happy to support pre-funding and what the Government are doing. Our view is that it will be in place and fit for purpose in months rather than decades. This is a plaster, to try to cover what is a potentially very large problem. Unless real intellectual thought is given to exactly how we can properly constitute a compensation scheme for the circumstances that banks are now in, the provision will be wholly inadequate.

Photo of Ian Pearson Ian Pearson Parliamentary Under-Secretary, Department for Business, Enterprise & Regulatory Reform, Economic Secretary, HM Treasury

I am glad that the Liberal Democrats are at least in favour of the principle of pre-funding. They seem in a great rush to introduce it. Given the turmoil in financial markets, now is certainly not the time.

I recognise some of the arguments that have been expressed about pre-funding. We appreciate the concern that levies would be a charge on banks’ profits and reduce banks’ ability to pay dividends. We recognise that the banking industry thinks that it might be able to earn more by investing the money itself, rather than by placing the money on deposit with the national loans fund, although recent events might have dented that argument a little.

Photo of Mark Hoban Mark Hoban Shadow Minister (Treasury)

Will the Minister accept that, given the way in which he is framing the debate, the levy is payable, potentially, by all financial services sector companies—not just by banks? That is what his clause says. It is not restricted to banks, building societies or credit unions—it includes all financial services. He needs to accept that when talking in the debate.

Photo of Ian Pearson Ian Pearson Parliamentary Under-Secretary, Department for Business, Enterprise & Regulatory Reform, Economic Secretary, HM Treasury

I certainly accept that we are taking the powers to enable us to do that in the future—and it is absolutely right to do so. I return to the principle: we fundamentally believe that banks should be paying up front, in case there is potential bank failure in the future. That is what our citizens would expect, and I think it is the right thing to do.

Photo of Mark Hoban Mark Hoban Shadow Minister (Treasury)

The powers enable not just banks to contribute to the cost of bank failure, but insurance brokers, independent financial advisers, fund managers and other categories of financial services business. Does the Minister accept that? He seems keen to focus the argument on banks, but other financial services companies, in accordance with the clause, will be able to contribute to the cost of bank failure too.

Photo of Ian Pearson Ian Pearson Parliamentary Under-Secretary, Department for Business, Enterprise & Regulatory Reform, Economic Secretary, HM Treasury

We have made it very clear that sectors should consume their own smoke when it comes to such matters. We discussed that in the debate earlier. I am not surprised that I did not persuade the hon. Gentleman to withdraw amendment No. 5, because he is simply completely against the principle of banks paying anything up front. The general principle that the costs of failure should be borne by the sector where that failure occurs is an important one, and we shall be pursuing it.

Photo of Rob Flello Rob Flello PPS (Rt Hon Hazel Blears, Secretary of State), Department for Communities and Local Government

Does my hon. Friend accept that in the modern financial world, all the different institutions are so interrelated that it is difficult to isolate one particular sector, such as the banks from the insurance companies? But I believe he is right that a sector should consume its own smoke.

Photo of Ian Pearson Ian Pearson Parliamentary Under-Secretary, Department for Business, Enterprise & Regulatory Reform, Economic Secretary, HM Treasury

My hon. Friend is absolutely right in pointing out that the parts of the financial services sector are extremely interrelated. All the different firms and companies in that sector share a great interest in the financial stability of the sector as a whole.

When it comes to pre-funding, it is important to recognise that pre-funding can allow the costs of bank failure to be spread over a period. It can reduce the pro-cyclicality of the post-funded system, in which banks have to contribute after a failure, when the financial stress is clearly greater. It is also important to recognise a point raised by the hon. Member for Wellingborough—that one of the great features of an up-front scheme is that any institution that failed would have previously contributed.

I stress that there is a debate still to be had here, if a decision is taken to introduce pre-funding in the future. We will want to have a lot of discussion about how a scheme would work: discussions between the Bank of England, the FSA, the banks and building societies and their associations and the Government. There will be a consultation before any step is taken on pre-funding. The Committee and others will also note that pre-funding  can be introduced only with parliamentary approval under an affirmative resolution procedure. The clause simply gives us the powers to introduce pre-funding at a later stage. It is a sensible piece of contingency planning and I commend it to the Committee.

Photo of Mark Hoban Mark Hoban Shadow Minister (Treasury)

We have had a useful debate. There are strong views on either side. The Minister needs to be very careful. He framed the debate in the context of banks consuming their own smoke and paying the cost of failure. I would agree that banks need to pay the cost of their failure; no one disputes that. The point at issue is how and when they do so. But the clause is not just about banks. It is not just about a pre-funding scheme for banks, and banks themselves paying for it; it affects the whole of the financial services sector as covered by the Financial Services Compensation Scheme.

The Post Office, for example, sells financial services products. Will it be covered by the scheme? Will we be asking the Post Office to pay up front into this scheme? The Minister has not talked about the Post Office, but I wonder whether it will end up having to contribute. We are asked to approve today a clause that might be used, which might cover banks and which might ask others beyond banks to contribute. It might be risk-weighted. It might be restricted to non-negligible billions, to use the Governor’s phrase. It might ask for just a token contribution. It might be built up over three years or 20 years. It is all very vague and insubstantial.

The Minister has not set out clearly how the scheme would work, if it were ever to be introduced. That is one of the failings. Setting aside the argument about principle—we disagree with the principle of pre-funding—even as it stands the clause lacks definition. It lacks a clear sense of where the limits are. The words that the Minister used do not necessarily reflect the full breadth of the potential scheme as set out in the clause. The risk is that the Government are embarking on a scheme and have no idea where they will end up. In supporting this, the Committee would have no idea where the scheme might end up in future years. I do not think that legislation should be made in this way.

If it is the Government’s view that pre-funding is needed, they should set out a far clearer idea of the nature of the scheme than they have laid before the Committee this afternoon. Whether members of the Committee have a fundamental disagreement of principle about whether pre-funding is right—I believe it is not right and Members on the other side of the room believe that it is right—we have not been given the detail that we need to determine whether it is a power that the Government should have. That is why I oppose the clause.

Question put, That the clause stand part of the Bill:—

The Committee divided: Ayes 8, Noes 2.

Division number 2 Nimrod Review — Statement — Clause 156

Aye: 8 MPs

No: 2 MPs

Ayes: A-Z by last name

Nos: A-Z by last name

Question accordingly agreed to.

Clause 156 ordered to stand part of the Bill.

Photo of Roger Gale Roger Gale Conservative, North Thanet 3:00 pm, 23rd October 2008

In the interests of clarity, clause 157 will come later because it is taken earlier, if you see what I mean. The procedure from now on is that where there is a clause without amendments, I will call the clause. If any hon. Member indicates that they wish to debate the clause I will call the Minister to move it and we will debate it. If nobody expresses any interest in the clause I will not call the Minister and waste his or the Committee’s time, and I will put it formally. I hope that that is understood.

Clause 158 ordered to stand part of the Bill.